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Using the House to Pay for Grandma

I’ve always got the nagging feeling that I’m not saving enough for retirement. Maybe because I don’t even know how much constitutes “enough.”

I know most Americans are in the same boat, and — to top it off — Social Security is going broke. Since more than 30% of retirees count on Social Security for 90% or more of their monthly income, this is a huge problem.

But when it comes to financing retirement, at least we’re not Chinese.

In the U.S., Social Security will exhaust its surplus by 2037. At that point, the program will bring in enough funds to pay roughly 75% of the promised benefits, leaving an average annual deficit of around $200 billion. To fix this, we will have to raise taxes, cut benefits, or some combination of the two.

China’s pension scheme will be underfunded by $116 trillion dollars by 2050, and will steadily get worse. The government currently has no plans for how to fix their problem, but a wealthy real estate magnate does.

He is Meng Xiaosu, president of China’s largest state-owned property developer.

Instead of trying to wring new taxes out of the system, he proposes that Chinese retirees take out reverse mortgages on their homes.

These allow homeowners to take out loans against the equity they’ve built up in their homes in the form of monthly payments that last until they die, sell, or move out. At that point, the total of the payments plus interest are repaid using the equity in the home. (I wrote about these extensively in Boom & Bust, May 2014.)

Since the Chinese hold 76% of their personal wealth in real estate, it only makes sense to tap this asset for retirement income. Except for one thing — to make such a program work, there must be new buyers in the years to come to keep home values up.

China currently has 1.3 billion people, with big population bulges in the 45- to 49-year-old range and the 25- to 29-year-old range. Younger age groups are markedly smaller because of the one-child policy. Over the next 35 years, demographers optimistically project the country’s population to remain flat, and then drop by 300,000 people from 2050 to 2090.

As I said, this is optimistic.

Today, Chinese women have an average of 1.6 children. It takes two children to replace both parents, so today the system builds in population reduction. The government recently relaxed the one-child policy, hoping to spur reproduction and slow the population decline, but so far the citizens don’t seem interested…

By holding families to only one child, the Chinese government inadvertently created a system where parents compete for everything for their children, from slots at university to spouses. All that fighting takes cash, so having more than one child would be quite the financial burden.

If couples stay on their current track of having few children, then the rosy projections of a stable population will fade, and the number of Chinese will dwindle even faster than anticipated. Among the weird outcomes from a falling population will be fewer home buyers, a situation that Harry has written about several times concerning Japan.

Fewer buyers should lead to lower home prices, which is a problem for the reverse mortgage industry.

In the U.S., reverse mortgages are guaranteed by the federal government (which means you and me), and there are strict limitations on the amount of equity that can be borrowed. We also have a gently rising population, so over time our real estate market should be at least stable.

In China, reverse mortgages are currently offered by just one company, an insurance firm, with no government backing. Granted, the market is minuscule today, with only 89 reverse mortgages outstanding. But there are 250 million elderly in China at the moment, a figure that’s expected to grow to 350 million over the next 35 years.

As the government looks for a way to pay for them all without breaking the bank, the reverse mortgage industry could take off… for a while.

However, when it becomes apparent that home prices can’t keep pace without the tailwind of population growth, the market should come crashing down.

Of course, reverse mortgages are just the latest twist in an already crazy Chinese property market. Easy credit has fueled speculative buying for years, causing a sizeable real estate price bubble that looks ready to pop.

In the end, the problem remains the same.

As populations age, the citizens transition from net producers to net consumers. Unless there are more workers added (meaning young people) that provide goods and services and pay taxes, or the older citizens have stored up an enormous amount of wealth, it will be almost impossible for the elderly population to maintain its standard of living.

Eventually, the Chinese government will get more involved, probably doing exactly what we must do here to fix our problem: lower benefits, raise taxes, or some combination of the two.

I’d imagine many people in China look at it the same way you and I do. They’re not sure how much is “enough” for retirement. But they’re certain the government will show up wanting more of what they have.

Rodney Johnson works closely with Harry Dent to study how people spend their money as they go through predictable stages of life, how that spending drives our economy and how you can use this information to invest successfully in any market. Rodney began his career in financial services on Wall Street in the 1980s with Thomson McKinnon and then Prudential Securities. He started working on projects with Harry in the mid-1990s. He’s a regular guest on several radio programs such as America’s Wealth Management, Savvy Investor Radio, and has been featured on CNBC, Fox News and Fox Business’s “America’s Nightly Scorecard, where he discusses economic trends ranging from the price of oil to the direction of the U.S. economy. He holds degrees from Georgetown University and Southern Methodist University.